Why Do Restatements Decrease in a Clawback Environment? An Investigation into Financial Reporting Executives’ Decision-Making during the Restatement Process

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  In Roundtable Session: Table 10: Auditing and Financial Reporting Quality

Abstract

Prior studies find that firms that voluntarily adopted clawback policies have experienced a reduction in restatements. I experimentally examine this outcome by investigating the influence of two key factors (i.e., executive compensation structure and auditor industry specialization) on financial reporting executives’ (hereafter “executives”) decision-making regarding a proposed restatement that will lead to a clawback of their incentives. My results reveal that executives (i.e., CFOs, controllers, and treasurers) are less likely to agree with amending the financial statements when a higher proportion of their pay is incentive-based; however, industry-specialist auditors act as an effective monitoring function by increasing their likelihood to agree. My results reveal a negative consequence of clawback regulation, as executives may be motivated to avoid restating the financials in the presence of clawbacks leading to an unintended reduction in restatements. These findings are important and timely because the Dodd-Frank Act requires that public firms establish a clawback policy.

Author

• Jonathan Pyzoha, Case Western Reserve University